Tag Archives: securities and exchange commission

An “alphabet soup” of federal agencies established since the 1930s have gradually supplanted the rule of Congress and the courts with the rule of supposed expertise. This accumulation of power is what James Madison identified in Federalist No. 47 as “the very definition of tyranny.” An example of this trend is the Securities and Exchange Commission’s increased use of in-house administrative law judges under the Obama administration.

Following high-profile losses in federal court—remember the insider trading charges against Mark Cuban?—the SEC decided to file fewer enforcement cases in courts presided over by independent judges. Instead, the agency began to take advantage of its in-house administrative law judges. Conveniently, a change in the Dodd-Frank Act authorized the agency’s judges to hear more kinds of cases and dispense more penalties.

Administrative law judges are agency employees. The proceedings they oversee provide fewer protections than court cases. They also tend to set stern deadlines and limit the right to factual investigation, often leaving defendants to rely on the SEC’s evidence. According to a 2015 Wall Street Journal analysis, the agency’s shift paid off: Through the beginning of that year, it won 90% of cases in its in-house court, compared with 69% of regular court cases. Administrative decisions can be appealed to court but are rarely reversed. That’s because the judges apply a deferential “clear error” standard to the agency’s factual findings.

The due-process problems inherent in this arrangement are apparent. Less obvious, at least to the SEC, is that it also violates the Constitution’s Appointments Clause, which requires Senate hearings and confirmation votes for department heads and other senior officials. To promote political accountability, the Constitution also requires that “inferior officers” with significant responsibility be appointed by the president or senior officials who are confirmed by the Senate.

This month, the 10th U.S. Circuit Court of Appeals ruled that the SEC’s administrative law judges aren’t mere employees but inferior officers. They take testimony, rule on motions, issue subpoenas, preside over triallike hearings, make factual determinations and can even enter judgments and impose penalties in certain circumstances. The court’s analysis was guided by a 1991 Supreme Court decision holding the same about “special trial judges” who had similar powers under the U.S. Tax Court. The SEC will surely appeal, and there is a high likelihood that the Supreme Court will affirm the lower court’s ruling.

The immediate problem for the SEC is that Congress hasn’t authorized the appointment of administrative law judges through the constitutional process. So the agency faces the risk, in cases it tries in-house, that its decisions will be voided. The SEC and its allies will push for a legislative fix so that in-house judges can be properly appointed. Congressional Republicans should use the demand for legislation as a bargaining chip for other reforms, such as restricting cases that can be heard in administrative courts.

But a legislative fix only heightens the contradictions of trying these cases outside of real courts. Due process requires that judges be neutral. A fix would make them political appointees.

Moreover, in Free Enterprise Fund v. Public Accounting Oversight Board(2010), the Supreme Court struck down an arrangement whereby appointed officers were double-insulated from removal. They could lose their jobs only for good cause, and the agency head with the power to remove them could himself only be fired for good cause. That kind of double protection, the court explained, impermissibly “subverts the President’s ability to ensure that the laws are faithfully executed” and “the public’s ability to pass judgment on his efforts.”

Administrative law judges are nearly identically insulated from political control. They can be dismissed only for good cause by their agencies, and even then only if the Merit Systems Protection Board agrees. If the 10th Circuit’s decision is upheld, this will almost certainly be the next shoe to drop, and it will leave administrative law judges subject to political control.

That means the in-house judges will be political appointees subject to the supervision of other political appointees—and at risk of dismissal for failure to follow instructions. Will agencies be able to maintain the pretense that they are “judges” in any meaningful sense? It’s difficult to see how.

The SEC’s overreaching may spell the end of the administrative state’s growth—marking the point when Congress and the courts started to regain lost ground. Thanks, Mr. Obama.

Messrs. Rivkin and Grossman practice appellate and constitutional law in Washington, D.C.

Fines levied by the SEC against a corporation for long-ago wrongdoing do not protect current investors.

By DAVID B. RIVKIN JR. And JOHN J. CARNEY

Two weeks ago, a unanimous Supreme Court rebuffed the Securities and Exchange Commission Gabelli v. SEC. The SEC maintained that its enforcement actions for fines under the Investment Advisers Act weren’t subject to the five-year statute of limitations. This wasn’t the first time the courts have pushed back a federal agency for overreaching. It won’t be the last.

But the SEC’s audacity prompts a broader policy question: What good is accomplished by imposing monetary penalties on corporations, as the agency attempted to do in Gabelli? The answer is that when such penalties are sought by the government, they probably do more harm than good.

Monetary damages, including penalties, that are awarded in private lawsuits are an attempt to compensate victims of corporate fraud and other unlawful behavior, usually shareholders or customers, making them as “whole” as the law can approximate. The SEC doesn’t seek monetary fines in most cases—it has an array of other enforcement options including injunctive or remedial relief. When it does pursue a fine, however, the purpose is solely punitive.

In Gabelli, for example, the SEC brought two sets of claims against principals of an investment firm who countenanced a client’s “market timing” scheme. The first claim sought disgorgement of profits to the government—a remedy that Gabelli didn’t appeal. But the SEC also sought large monetary fines designed solely to punish the defendants and brand them as wrongdoers.

Who is the wrongdoer in such a situation? The company officials who made the bad decisions? The board of directors? The shareholders? Pinning a wrongdoer label on the corporation as a whole or fining a corporation in this way—years after any alleged wrongdoing—punishes current shareholders for conduct that benefited a largely different group of shareholders, if any benefit was conferred at all.

From a current shareholder’s point of view, government-imposed corporate fines are virtually indistinguishable from a tax on investing, and are thus a disincentive for doing so.

Gabelli isn’t the only case when the SEC sought penalties involving ancient conduct. In January 2006, McAfee, the software company, consented “without admitting or denying the [SEC’s] allegations” to pay a civil penalty of $50 million for unlawful conduct alleged to have occurred between 1998 and 2000.

Similarly, in August 2003, UBS PaineWebber agreed to a $500,000 fine in connection with its unacknowledged failure to supervise a former registered representative who served jail time for defrauding certain clients. The conduct ended by March 1998, approximately five and a half years before the SEC instituted administrative proceedings.

More recently, the SEC fined Eli Lilly $29 million in December 2012 for alleged misconduct that purportedly began more than a decade ago.

The principal rationale for levying fines is to deter corporate wrongdoing. The mismatch between the shareholders that benefit from misconduct and those that are ultimately punished undermines this rationale.

Corporate fines are equally problematic when considered as punishment for a manager’s bad conduct. Fine an individual for his conduct, and you are likely to deter him from doing it again. Fine a corporation, and the managers responsible for the misconduct have almost always left or been fired long beforehand. New managers are in place, and for them the tab is just a price of doing business.

Moreover, even the threat of government fines or penalties puts immediate, intense pressure on a corporation to settle, regardless of the merits. A protracted legal fight means a public-relations nightmare. It could also impinge on corporate earnings, the reputations of current executives, and relationships with regulators and other business concerns.

Whether the corporation is actually culpable of wrongdoing is a consideration, but it may not be a major one. That question can be beside the point of getting back to business and avoiding a prolonged battle with the SEC. In the large number of settlement scenarios where actual guilt isn’t the most pressing or relevant consideration, the fines don’t by definition deter any future misconduct.

In any event, when the government obtains fines from corporate wrongdoers, the monies rarely go to any ascertainable “victims”—they merely transfer funds from businesses to an already bloated public sector. With the aggregate penalties often running into the billions of dollars, the economic distortions involved are substantial.

Notwithstanding the Supreme Court’s rap on the SEC’s knuckles for its behavior in Gabelli, this agency and others, both federal and state, are increasingly aggressive in seeking fines. Last month the SEC’s website touted the $1.53 billion in penalties that it has accrued from enforcement actions related to the 2008 financial crisis. The reported monetary relief to victims amounted to $1.15 billion. Stated another way, the government recovered 33% more for itself than for investors.

The SEC has the authority to return some of those fines it collected to injured investors, but the agency website is silent on that point. Bigger fines may demonstrate an agency’s prowess or increase its bragging rights. But that has nothing to do with whether any given amount is appropriate or just punishment—or indeed, any punishment at all.

There is a better way, and it doesn’t mean letting corporations off the hook for bad behavior. In addition to victims’ private lawsuits that hold corporations accountable, government actions can pursue wrongdoers in a variety of ways, including: disgorgement of ill-gotten gains to victims, injunctions to curtail harmful conduct, and the imposition of examiners and monitors, all of which can adequately address and cure the underlying misconduct.

For any government agency—but in particular for the SEC, which supposedly seeks to protect investors—these types of equitable remedies, not punitive monetary fines, should be the remedies of first resort.

Messrs. Rivkin and Carney practice law at BakerHostetler. Mr. Rivkin served in the Justice Department and the White House Counsel’s Office in the Reagan and George H.W. Bush administrations. Mr. Carney served in the SEC’s Division of Enforcement and the Justice Department as a Securities Fraud Chief.